Question

The new piece of equipment will have a cost of $1,200,000, and it will be depreciated on a straight-line basis over a period of five years (years 1–5).
•	The old machine is also being depreciated on a straight-line basis. It has a book value of $200,000 (at year 0) and three more years of depreciation left ($50,000 per year).
•	The new equipment will have a salvage value of $0 at the end of the project's life (year 5). The old machine has a current salvage value (at year 0) of $300,000.
•	Replacing the old machine will require an investment in net working capital (NWC) of $20,000 that will be recovered at the end of the project's life (year 5).
•	The new machine is more efficient, so the incremental increase in earnings before interest and taxes (EBIT) will increase by a total of $500,000 in each of the next five years (years 1–5). (Hint: This value represents the difference between the revenues and operating costs (including depreciation expense) generated using the new equipment and that earned using the old equipment. )
•	The project's required rate of return is 12%.
•	The company's annual tax rate is 35%.

Complete the following table and compute the incremental cash flows associated with the replacement of the old equipment with the new equipment.

	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5
Initial investment	$1,200,000
EBIT						$500,000
Less: Taxes
Plus: New depreciation
Less: Old depreciation
Plus: Salvage value
Less: Tax on salvage
Less: NWC
Plus: Recapture of NWC
Total Net Cash Flow					$565,000

The net present value (NPV) of this replacement project is   .

Answer 1